Digging Into China’s Growing Mountain of Debt

Data that breaks the country’s borrowing into its bank, corporate, government, and household components can help you get a more-nuanced picture.

China Debt as a Matter of Concern for Investors

Some prominent investors are worried about China’s debt. George Soros sees an “eerie resemblance” between conditions in China now and those in the U.S. leading up to the financial crisis in 2008. “It’s similarly fueled by credit growth and an eventually unsustainable extension of credit,” Soros told the Asia Society in New York in April.

BlackRock Chief Executive Officer Laurence Fink was asked about China’s mounting debt on Bloomberg TV in May. “We all have to be worried about it,” Fink said, adding that he remains bullish on China’s economy in the long run.

And in June a Goldman Sachs report warned that the country’s large and unaccounted-for shadow-banking activities raised concern “about China’s underlying credit problems and sustainability risk.”

Indeed, many segments of the Chinese economy have taken on considerable debt, especially since the global financial crisis. Over the past decade, total debt grew 465 percent. Debt rose to 247 percent of gross domestic product in 2015, from 160 percent in 2005. Bloomberg Intelligence breaks China’s total debt into four components: bank, corporate, government, and household. For tickers, run {CHBGDCOP Index <GO>} and then type {DES <GO>}. Bank debt has decreased slightly in relation to the size of the country’s economy over the past 10 years, to 19 percent of GDP in 2015. Corporate debt, meanwhile, jumped to 165 percent of GDP from 105 percent. Government debt rose to 22 percent of GDP. Household debt has increased to more than 40 percent of GDP, a rise of 23 percentage points.


Despite that rapid growth, household debt in China is far below levels in the U.S. before the subprime crisis. At its 2007 peak in the U.S., household debt reached almost 100 percent of GDP. What’s more, in China household savings are twice as large as debt. Deposits were about 55 trillion yuan ($8.4 trillion) at the end of 2015, while debt was 27.4 trillion yuan.

Another big difference between China today and the U.S. during the subprime bubble is that Chinese residential properties are typically purchased with significant down payments. According to the China Household Finance Survey, the average household debt in urban areas amounted to only 11 percent of home value in 2012. Mortgage debt remains comparatively rare. That showed up in the survey data: The median household debt was zero percent. The same survey also found that if housing prices were to decline 50 percent, less than 14 percent of mortgages would exceed the value of the properties. Given China’s high savings rate and low leverage, it seems unlikely that households would cause a financial crisis.

If overwhelming debt does trigger a crisis in China, it’s more likely the spark would come from corporations and their main creditors, the banks. China’s bond market has shown signs of growing stress, including 17 defaults through June 30, almost triple the number in 2015. That and a series of delayed payments prompted rising credit spreads and cancellations of new issues.

Leverage problems aren’t evenly spread across Chinese corporate sectors. Energy and materials companies have the lowest ability to service debt. Among Chinese energy companies in 2015, the median earnings before interest and taxes was less than one times total interest expense, according to Bloomberg Intelligence. At materials companies, the median EBIT was twice the interest expense. By contrast, Chinese health-care companies have median earnings of more than nine times interest expense. Information technology and telecommunications-services companies generate earnings that are more than five times interest expenses.

While certain industries and enterprises have a lot of debt, Chinese companies’ average leverage isn’t high, according to a recent International Monetary Fund working paper. Since 2006, listed companies that aren’t state-owned have reduced median liabilities to 55 percent of common equity. At state-owned enterprises, however, median leverage has been unchanged at about 110 percent. Leverage has increased at the tail end of the distribution, driven by rising debt at companies in construction, mining, real estate, and utilities. An increasing share of debt is attributed to a few companies with high leverage ratios.

China is different from other markets in an important way. Many large corporations and nearly all the major banks are state-owned. In other words, the debtors and creditors are ultimately owned by the same entity. That means the country could address debt problems in some unusual ways. One scenario is the state could take from the prosperous—coastal regions or high tech, for example—and give to the struggling. Another is that the government could simply cover debt. Some unprofitable state-owned enterprises are supported by lending from their banks essentially to keep employment at acceptable levels. Such debts could eventually be absorbed by the state as part of its social welfare expenditures.

As China gradually opens up its stock and bond markets, more capital could become available to deal with the country’s obligations. The potential inclusion of Chinese stocks and bonds in the global indexes over the next few years would help facilitate that.

This isn’t to say that China doesn’t have some serious problems. Growth is slowing and the economy needs major restructuring. There will be winners and losers and turmoil in the market. Shadow-banking activities add another risk. It isn’t certain that the government will handle the challenges in the next decade as deftly as it has in the past. The country’s economy is far larger and more complex.

Fortunately for the rest of the world, China has a high savings rate. Capital controls aren’t fully lifted, making capital flight difficult. The government has almost complete control of the banking industry. In addition, China’s listed banks get about 70 percent of their funds from deposits. In comparison, U.S. investment banks in 2008 relied heavily on short-term money-market funding.

Such circumstances make it unlikely that China’s debt will spark a global crisis in the near future.
 
Sun is an equity market specialist at Bloomberg in Hong Kong.
 

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